Professional Documents
Culture Documents
Calls
The upper bound is C < S
If there are no dividend payouts, the lower bound is
C > max [ 0, S - K(1+r)-T]; i.e., C > max [ 0, S - PV(K)]
C=S
C=S-PV(K)
C=S-K
Note that C>S-K is a
weaker lower bound
than C>S-PV(K)
0
PV(K)
S
David Dubofsky
and 16-1
0
- ST
David Dubofsky
and 16-2
______At Expiration______
Today:
ST = 42
Buy call
-4
+2
Sell stock
+44
- 42
Lend -39.80
+ 40 + 40
+0.20
ST = 37
0
- 37
+3
David Dubofsky
and 16-3
Buy call
Exercise call
Sell stock
-C
-K
+S
>0
-3.90
-40 (thereby acquiring the stock)
+44
+0.10
David Dubofsky
and 16-4
David Dubofsky
and 16-6
Proposition IV:
(a)
(b)
C MAX
(c)
(d)
0
S - K(1 r)- t1
S - D1 (1 r)- t1 K(1 r)- t2
S - D1 (1 r)- t1 D2 (1 r)- t2 K(1 r)-T
Exercising an option early destroys its time value, so you will only
want to exercise early if the option has no time value.
David Dubofsky
and 16-8
Suppose that today, the day before a stock trades ex-dividend, a call is
selling is selling for its intrinsic value:
C(with-div) = S(with-div) K
C
C (with-div)
Min
C(ex-div)
div
PV(K) K S(ex-div)
S(with-div)
It is possible that the American call will fall in value from C(with-div) to as
low as C(ex-div), on the ex-dividend day. American call owners will
exercise early, rather than watch the call decline in value.
David Dubofsky
and 16-10
What if P < K S?
Then, P K + S < 0
Or, - P + K S > 0
Today:
Buy put
Buy stock
Exercise put
P
S
+K
>0
Numerical Example.
What if P = 2.70 when K = 40
and S = 37? (2.70 < 40 - 37)
Today:
Buy put
Buy stock
Exercise put
2.70
37
+ 40
+ 0.30
David Dubofsky
and 16-12
Today
Buy put
Borrow
Buy stock
P
+K(1+r)-T
S
>0
+(KST)
K
+ST
K
+ST
>0
P=K
P = K(1+r)-T
E
P=K-S
P=K(1+r)-T -S
E
PV(K)
A
K
Figure 16-5
Pricing Boundaries for Puts on Non-Dividend Paying Stocks
AAA shows the American put boundaries.
EEE shows the European put boundaries
David Dubofsky
and 16-14
David Dubofsky
and 16-15
Put-Call Parity
For European options on non-dividend paying stocks,
put-call parity is:
C P = S PV(K)
For European options on stocks paying known
dividends, put-call parity is:
C P = S PV(Divs) PV(K)
For European options on stocks paying unknown
dividends, put-call parity is:
S PVL(DivsL) PV(K)> C P > SPVH(DivsH) PV(K)
David Dubofsky
and 16-16
Today:
Sell call
+C
Buy put
-P
+(K-ST)
Buy stock
-S
+ST
+ST
-K
0
-K
0
Borrow
+K(1+r)-T
>0
-(ST-K)
David Dubofsky
and 16-17
ST=37
-4.50
+2.50
+42.00
-39.41
+0.59
ST=44
0
-3
-37
+40
0
+4
0
-44
+40
0
David Dubofsky
and 16-18
If r > 0, an at the money call is worth more than an at the money put with
the same K and T.
You can replicate the payoff from any position with the other three
securities (e.g. buying a put = selling stock, lending, and buying a call).
David Dubofsky
and 16-19
S = C-P+PV(K)
-S = -C+P-PV(K)
-P = S-C-PV(K)
P = -S+C+PV(K)
C = S+P-PV(K)
-C = -S-P+PV(K)
PV(K) = S-C+P
-PV(K) = -S+C-P
David Dubofsky
and 16-21
S=74.50, K=75, C=9, P=8.75, r=6% per year, T=221 days = 0.6055 year,
K(1+r)-T = 75(1.06)-0.6055 = 72.40.
The last ex-dividend date was on 2/7/2000, and the dividend amount was
$0.50 per share. Thus, assume D1H=0.55, t1=90 days=0.2466 year, PV(D1H)
= 0.5422, and D2H=0.60, t2=182 days=0.4986 year, PV(D2H) = 0.5828.
Thus, there are no arbitrage opportunities. However, notice the width of the
no-arbitrage range, C-P.
David Dubofsky
and 16-23
If you have created some slides that you would like to share with the
community of educators that use our book, please send them to us!
David Dubofsky
and 16-24
David Dubofsky
and 16-25
Intrinsic Value, I.
It is really vital that you remember:
Intrinsic Value can be calculated whether an option is dead
or alive.
That is, you can always calculate the intrinsic value of an option.
David Dubofsky
and 16-26
David Dubofsky
and 16-27
David Dubofsky
and 16-28
David Dubofsky
and 16-29
David Dubofsky
and 16-30
David Dubofsky
and 16-31
David Dubofsky
and 16-32
David Dubofsky
and 16-33
S=K
S>K
S-K
0
S
-K
0
0
S
-K
S-K
David Dubofsky
and 16-34
David Dubofsky
and 16-35
Therefore, at expiration:
S<K
S=K
S>K
Short Call:
Long Put:
Long stock:
0
K-S
S
0
0
S
-(S-K)
0
S
Borrow:
-K
-K
-K
David Dubofsky
and 16-36
David Dubofsky
and 16-37
K
P+S-C=
(1+r)
K
P+S-C=0
(1+r)
OR,
K
P+S=C
(1+r)
David Dubofsky
and 16-38
(S + P - C)(1+r) = K
Now, if you are looking for a really useful tattoo..
David Dubofsky
and 16-39
David Dubofsky
and 16-40
David Dubofsky
and 16-41
David Dubofsky
and 16-42
P + S - K/(1 + r)
David Dubofsky
and 16-43
David Dubofsky
and 16-44
Arbitrage Example
Suppose:
S = 40
K = 40
C = $3
P = $2
r = 6%/year
T= 3 months
David Dubofsky
and 16-45
Today:
Buy put:
Sell call:
Buy stock:
Borrow:
- $2
+ $3
+ $40
+ $39
At expiration:
We receive: K = $40
We repay: ($39)(1.015) = $39.59
Difference of $0.41
David Dubofsky
and 16-46